Citigroup Forced to Adjust Earnings After Mexico Fraud

Citigroup has lowered their fourth-quarter earnings by $235 million. The cut will affect the full-year results equally. Financial transactions between Banamex, Citigroup’s Mexican subsidiary, and Oceanografia S.A. de C.V. force the parent to adjust earnings on the 2013 financial statements.

Banamex, Banco Nacional de Mexico, allocated $585 million in short-term credit to Oceanografia. Oceanografia, or OSA, is a Mexican oil services company that contracts with Petroleos Mexicanos, or Pemex. Pemex is the Mexican state-owned oil company and OSA is their supplier of oil.

Pemex and OSA are both clients of Citigroup. The bank’s Mexican subsidiary extended the credit to OSA to finance their accounts receivable collection from Pemex. The reported accounts receivable at the end of 2013 was $585 million. The bank announced Friday that the actual receivables are much less than originally reported by OSA. The valid figure is closer to $185 million. The fraudulent information provided by the Mexican oil supplier has forced Citgroup to adjust their fourth-quarter net income in the transactions services business by $400 million.

Citigroup partially extended the credit to assist Pemex in hedging oil price risk, according to the Wall Street Journal. A complex plan that appears to be strategically calculated but backfired when the bank discovered OSA was suspended from forming new contracts with Mexican government. Citigroup partnered with Pemex and began investigating the credit exposure. The conclusion was that $400 million of transactions between Pemex and OSA was fraudulent thus invalid.

The $400 million in bad loans was partially offset by $40 million in variable compensation expense for Banamex. The $360 in pre-tax earnings translates $235 million after-tax.

The $235 million earnings reduction is a loss the world’s seventh largest bank, by market capitalization, can recover from, but nonetheless a fraudulent activity that Chief Executive Michael Corbat intends to resolve. Corbat had already been on the rocks for disappointing 2013 year in which analysts estimated greater cost cutting and profit growth. The stock is down 6.6 percent in 2014.

Corbat said in a statement that Banamex has been working with Mexico’s attorney general to criminally charge perpetrators and explore legal options. As of this morning, Reuters has reported that a news conference will be held by Mexico’s attorney general office to discuss loans between Banamex and OSA. Pemex will also participate in the meeting, according to a Pemex official.

Citigroup believes that the fraud related to Banamex’s account receivable financing program is isolated to this one client. The bank will perform due diligence however to accurately report the incident. Other than the receivables financing program, Banamex has $33 million in loans or letters of credit outstanding to OSA. The bank is analyzing whether these credit transactions are also impaired.

An OSA representative has yet to comment on the incident.

Citigroup is forced to issue adjusted earnings on their annual report after the Mexico fraud involving their subsidiary and OSA. The changes will be filed Monday to reflect valid fourth-quarter earnings. Citigroup stock value has fluctuated between $47.72 and $49.14 since the news released.